Description

Company Overview

RBC Bearings, Inc. (“RBC” or the “Company”) is a leading manufacturer of highly engineered precision bearings, gearings, and related components for the industrial and aerospace/defense end-markets. RBC’s precision products are critical to reducing friction of various moving parts in mechanical systems, thereby optimizing energy efficiency and controlling pressure and flow. RBC focuses on the higher end of the market, where its value-added engineering capabilities and reputation for ‘100% quality performance/ 100% on-time delivery’ allow the Company to differentiate itself and command premium pricing and contract terms. The Company is headquartered in Oxford, CT, with 38 manufacturing facilities across 11 countries, while 92% of its revenues are derived from within the United States. RBC has a current market capitalization of $9.1BN, total annual revenues of $1.6BN, and operates on a March 31^st fiscal year end.

While the Company serves a broad range of sub-markets, it classifies its operating results accordingly:

• Industrial (67% of total revenues; 45% gross margins): Supplies gearings, bearings and engineered components for metals/mining, aggregate/cement, food/beverage, oil/gas, forest, and other general industrial applications. Key OEM customers include Caterpillar, Komatsu, and Halliburton, along with various aftermarket distributors. Recently, Industrial segment YoY revenue growth has languished (-3.5% YoY in last reported quarter) due to difficult prior year comps with certain customers clearing out backlog due to recovering supply chains from COVID last year. Management still expects positive growth for the Industrial segment in FY2025. 
• Aerospace/Defense (33% of total revenues; 40% gross margins): Supplies bearings and engineered components to commercial aircraft (68% of segment) and defense aircraft and weaponry (32% of segment) applications. Recently, Aerospace/Defense segment revenue growth has been very strong (+24% YoY in last reported quarter), largely due to strong orders from the Company’s precision products for key strategic U.S. defense programs including missiles, submarines, planes, and helicopters.

Investment Thesis

• Strong barriers to entry: RBC competes in highly technical and/or regulated markets requiring complex custom design and strict quality requirements. As many of its products are manufactured to conform to OEM specifications at the design phase, with approval processes lasting up to 6 years, RBC becomes the sole or primary source for most of its product platforms (currently representing >70% of its revenues). As a result, competitive intensity is limited once RBC is spec’d to the OEM’s specifications, paving the way for predictable aftermarket sales.
• Earnings power resilience: Due to its sole/primary source status with customers, RBC generates 52% of its revenues through the aftermarket, resulting in less discretionary and more recurring demand for its products. RBC’s diverse end-market exposure leverages it to a mixture of secular forces, thereby dampening cyclicality. Further, management has focused on driving a variable cost structure and has been able to optimize its inventories particularly during downcycles. For instance, in FY2010 (Great Recession), while revenues declined 23%, FCF grew in that year. In FY2021 (COVID onset), while revenues declined 16%, FCF also grew in that year.
• Compelling FCF/share growth algorithm: RBC’s track record and future opportunities suggest that it should continue to grow free cash flow/share at a sustainable double-digit rate.
  • Organic growth: The company targets at least mid-single digits organic revenue growth through cycles, which it has consistently delivered over the past 20 years. RBC’s organic growth is comprised of low-single digit industry growth plus market share gains. Market share gains are often obtained via competitor displacement of tier 3 or tier 4 suppliers who struggle to compete with RBC’s robust product innovation. Despite its market leading position, RBC controls only 2% of the fragmented ~$80BN global bearings market, providing ample runway.
  • Inorganic growth: Management has exhibited a strong track record of accretive M&A that has historically bridged mid-single digit organic growth to low double-digit total revenue growth. While tuck-in acquisitions are the Company’s bread and butter, in July 2021 RBC completed a transformational acquisition of Dodge for $2.8BN at 11x run-rate synergy EBITDA. In addition to realizing scale and diversification in key industrial markets, management has already realized 80% of its high-end cost synergy estimate of $100M– roughly three years earlier than planned. The Company’s trailing net leverage ratio is now down to 2.1x, providing it with the balance sheet capacity to resume more sizeable accretive M&A. 
  • Margin enhancement: RBC has proven a persistent focus on continuous manufacturing improvement, which we expect to translate into 50bps+/year of ongoing operating margin expansion for the foreseeable future. Prior to the onset of COVID and subsequently the Dodge acquisition, RBC averaged adjusted operating income margin improvement of 500-600bps/year (FY2005-FY2020). Since the Dodge acquisition, the Company has expanded adjusted operating income margin by 2.4%, or 800bps/year (FY2021-FY2024), resulting from aggressive synergy capture. Going forward, RBC should capitalize on several opportunities, including:
    • Improving Aerospace/Defense gross margin (40%) toward Industrial segment levels (45%), in part through price re-setting on certain defense contracts that were last established in 2020/2021
    • Leveraging latent Aerospace/Defense manufacturing capacity built up prior to COVID
    • Capturing remaining Dodge cost synergies
    • Ongoing SG&A leverage including from future acquisitions
  • Capital allocation: With minimal capital expenditure requirements (3-3.5% of revenues), strong free cash generation has enabled RBC to reduce its post-Dodge acquisition net leverage ratio from 4x to now 2.1x, while simultaneously repurchasing shares opportunistically and paying a 5.0% dividend on its preferred stock. The preferred stock will mandatorily convert to common on October 16, 2024. Thereafter, an argument can be made that RBC can support a recurring dividend for common shareholders in the future.

Taking the above thesis into account, it should not be surprising that RBC has produced a total shareholder return of 16.5% over the last 20 years. Considering the Company’s strong track record of execution, barriers to entry, earnings resilience through cycles, and proven strategy to capture share in a fragmented market, the Company trades at a reasonable multiple of 19x NTM EBITDA. Precision equipment comps TransDigm Group, Inc. (TDG) and HEICO Corporation (HEI), who similarly enjoy 50%+ aftermarket mix and sole/primary source supplier status, though focus primarily on aerospace/defense applications, trade at 22x and 35x NTM EBITDA, respectively. RBC’s recent weakness in its Industrial segment has likely masked its aerospace/defense strength from investors. In 2024 YTD, RBC’s stock price has been flat while TDG and HEI stock prices are up 44% and 36%, respectively.

Risks and Mitigants

• Raw material, employee, and supply chain disruptions– 7% of U.S. hourly employees participate in collective bargaining agreements
• Government and defense budget spending – approximately 2% of RBC’s total Company revenues are made directly, and it estimates an additional 9% made indirectly, to the U.S. government
• Internal controls material weakness identified in first quarter 2023– Deloitte has been the Company’s auditor since 1990

Catalyst

M&A (strong track record of success)

Bounceback in industrial segment